When It Comes To Tax Cuts, Neither Side Is Blinking

As the U.S. edges closer to a year-end "fiscal cliff," Democrats and Republicans haven't budged in their fight over expiring tax cuts for the wealthiest Americans — and how best to help the middle class and get the country back to work.

Wednesday's Senate votes on rival tax proposals are largely symbolic. The Democrats' tax plan would extend Bush-era cuts for a year to everyone except individuals earning more than $200,000 and families that make more than $250,000; the Republicans' plan would extend the cuts for all.

At the heart of the impasse is a decades-long debate over a central notion in an economic theory once championed by President Ronald Reagan: that wealthy individuals invest their savings from tax cuts in ways that create jobs further down the income ladder.

This "trickle down" idea has become an article of faith for many Republicans and so-called supply-side economists, though many analysts are skeptical. But one thing economists do agree on is that uncertainty over whether the tax cuts will be extended — and for whom — is the biggest threat to the economy.

Correlation And Causation

For Neil Buchanan, who teaches tax policy at George Washington University of Law, the proof isn't there that tax cuts boost hiring. A chart comparing tax rates and job creation would show no obvious correlation, he says.

"Look at the big-growth era of the '90s, when tax rates went up, and virtually no growth in the 2000s, when tax rates were down," Buchanan says.

But Brian Domitrovic, author of Econoclasts: The Rebels Who Sparked the Supply-Side Revolution and Restored American Prosperity, is just as convinced that Reagan-era tax policy has paid economic dividends — even during that period in the '90s.

"During the 1990s, you really had erratic growth. GDP was up and down and then finally locked into a 4 percent to 5 percent growth range from about 1996 onward," Domitrovic says.

"In the latter half of the decade, when it was clear that the only option for taxes was to go down — what with the Republican Congress and the surpluses — there was fast growth," he says.

Save It Or Spend It?

Supply-siders cite what's known as "entrepreneurial incentive" to make their tax case. It assumes wealthy individuals will invest their tax savings in innovative, job-creating activities — either using the extra cash to fund startups or simply expanding businesses they may already own.

While economists don't question that such an incentive exists, they do lock horns over its impact.

Joseph Minarik, senior vice president and director of research at the centrist Committee for Economic Development, points to research showing that the richer you are, the more likely you are to save any tax-cut largesse. In an uncertain economy, such as the current downturn, that trend is exacerbated.

"Savings is virtuous," says Minarik, who was associate director for economic policy at the White House Office of Management and Budget during the Clinton administration. "But the name of the game in the long run is to consume more, and right now, that's what we need to stimulate the economy. We need more demand."

Gary Clyde Hufbauer, a fellow at the nonpartisan Peterson Institute of International Economics, agrees. "If these folks are buying Treasury bonds or corporate stocks, you're not going to get much of a kick in the economy," he says.

Hufbauer says that in the early 1980s, when the top marginal tax rate dropped from 70 percent to 50 percent, the entrepreneurial incentive made a difference, but with top marginal rates now closer to 30 percent, the effect is considerably diminished.

(If the cuts are allowed to expire, the top marginal tax bracket would increase to 39.6 percent from 35 percent for families and to 36 percent from 33 percent for individuals.)

On the other hand, Hufbauer doesn't believe the government is going to get as much revenue as Democrats hope if the tax cuts are allowed to expire for the wealthiest individuals.

"If you raise the tax rates on these people, they will spend more time with their accountants trying to figure out how to get their tax rates down," he says. "So, you don't get as much money out of them as you think you're going to."

It's The Uncertainty, Stupid

But economists on both sides of the supply-side debate are less concerned with which party wins the latest tax cut fight than they are over the prospect that Congress will do nothing — as is almost certain, at least until the November election. That, they agree, is the worst-case scenario.

"The most important thing is to have marginal tax rates stable," says Luigi Zingales, who describes himself as a "reasonable supply-sider." He says the uncertainty increases doubt about the economy.

Like other supply-siders, Zingales, who teaches at the University of Chicago's Booth School of Business, is also concerned about the debt.

For him, raising enough revenue to bring down the deficit and debt trumps the entire tax issue. As a result, he's come to a conclusion that might sound like blasphemy to fellow supply-siders:

"I don't see a path to fiscal stability that does not include higher marginal tax rates," he says.